How to Figure Out the Actual Cost of Your Employees

Hiring tends to be more expensive than expected. Here's how to figure out what it will really cost your business.
President and CFO, CFOwise
September 08, 2017

Hiring employees always seems to cost more than entrepreneurs and business owners expect. Besides the hourly wage or salary, there are mandatory taxes and benefits, paid time off, insurance, retirement and so much more that increases the amount you spend to bring on help.

Knowing how much you spend for each employee will help you improve your business results in four key ways:

  1. You will correctly cost their time.

  2. You will price your products and services more profitably.

  3. You’ll help your staff understand the entire value of the compensation package you provide.

  4. You can plan for the exact costs you’ll incur whether your workforce grows, shrinks, or stays the same.

Time and job costing

To start, let’s get on the same page about what “burdened” means. This reflects the total cost of each of your employees, not just their salary or wages. When your employees do work that directly results in the production of goods or services, you should account for their time on a burdened basis.

For example, let’s assume you have an employee earning $20/hour. You determine that this employee’s burden rate is 30 percent of their hourly wage, or $6.00 per hour, resulting in a burdened rate of $26.00/hour.

If it normally takes this employee two hours to assemble a product, then the total direct labor cost is $52.00 per product. If, however, your employee requires three hours to assemble the product, knowing the burdened rate will help you understand how much the extra hour will impact the profit you make on that product.

It is important to set up your accounting software to properly capture the wages and the payroll burden as direct costs so that you can correctly track and understand your gross margin.

Preferred pricing

You should never create a price for your products or services without understanding all of the costs it takes to create, sell and deliver them. Labor is almost always the first or second largest expense in that equation, meaning it has a lot to do with how you should price your products or services. How much profit you make will, ultimately, have a lot to do with where you set your prices in relation your labor expenses.

Continuing with the $26/hour burdened labor rate, let’s assume labor is the only cost directly related to delivering services to your customers.

If you desire a 50 percent gross margin after direct costs, then you should charge your customers $52/hour ($26/50 percent = $52) for the use of every one hour of your employee’s time. If you have other material costs associated with manufacturing a product, then you add the burdened labor cost to the material and scrap costs to determine your total cost to manufacture the product. By determining your price in this manner, you will know exactly what your margins should be.

Total compensation package

In addition to understanding your labor costs and setting your prices accordingly, knowing the total you spend on each employee is helpful when you communicate with them about the overall compensation they receive. Many employees do not understand how much more it costs you than the net paycheck amount that gets directly deposited to their bank account every two weeks. Whenever you discuss compensation with your employees, you should know their total compensation and be willing to show it to them.

If the employee in the example above gets an offer to work somewhere else for $21/hour, he may consider leaving for more money. But is it really more money when you consider the total benefits program? If you pay 100 percent of health insurance costs and offer a generous match for 401(k) contributions while the prospective employer does neither, the employee may need help understanding that the new job may not really be a step ahead financially.

Accurate forecasts

Since labor is likely the first or second largest expense you incur, and since the total costs of each employee can be calculated exactly, there is no reason you should forecast your labor expenses blindly.

Keeping a spreadsheet of all of your employees, their annual wages, payroll taxes, benefit costs and so on is a powerful tool for forecasting the future. And, if you ever realize a variance in your budgeted labor and the actual expenses incurred, this tool will help you find the problem immediately.

I created a free spreadsheet to help you assess the total cost of each employee. It is a simple tool, but it can make all the difference as you strive to recruit and retain top employees and use their skills and talents to help your business grow and improve its cash flow and profitability.

Ken Kaufman is the President & CFO of Aribex®, an innovator of handheld devices disrupting medical imaging globally. As an award-winning executive with almost two decades of experience starting, growing, leading, and financing dozens of organizations, Ken is a highly sought-after speaker and author, including a best-seller, Impact Your Business.

A version of this article was originally published on February 19, 2012.

Photo credit: iStockphoto/ersler

President and CFO, CFOwise